With so many bank failures, what happens if Schwab, Fidelity, or Vanguard were to go bankrupt?
Here, we continue a series discussing economic shifting with inflation and volatility.
The current financial climate is causing people to turn to money market accounts and brokerages instead of traditional banking.
However, this shift in investment strategy also raises concerns about the safety of people’s money.
With all these banking failures, should you be worried if Schwab, Vanguard, and Fidelity were to go under?
These three companies have money market funds that appear to offer attractive returns compared to high-yield savings accounts currently. The past few months have been particularly alarming for those of us who do not remember 2008.
Key points to take away from this article
- Difference between a bank and a brokerage
- What is a money market fund at your brokerage?
- Brokerage cannot invest your money as they would like
- Money you give a brokerage should be with a custodian
- Brokerages have SIPC insurance protecting $500,000 of your money
- Many brokerages have excess SIPC insurance
- If a brokerage fails the assets are transferred from a custodian to another brokerage
Bank vs. Brokerage: What’s the Difference?
A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. The key part is while simultaneously making loans so keep that in mind before we discuss a brokerage..
Let’s first start by looking at Silicon Valley’s balance sheet. You can see the cash is a liability, and they have interest-bearing deposits.
Ultimately, these are what led to the collapse. A bank takes deposits from customers and uses that cash to invest and provide other products such as loans. A brokerage may have an affiliated bank, but the brokerage cannot use your money in another investment aside from where you allocate it.
If the bank does a poor job, we may not get our deposits back. However, we have FDIC insurance for $250,000 or $500,000 if it is a joint account. FDIC insurance only covers cash, not investments.
What is a brokerage?
A brokerage is a firm that acts as an intermediary who makes matches between buyers and sellers of stocks, bonds, and other financial assets.
A brokerage is an institution that cannot invest your cash for their own gain. If you find they are holding your capital and investing it, that could be a red flag. Typically, they make money by managing your capital and providing other services.
At one time, this was per stock transaction, but Robinhood disrupted that. Now they provide ETFs and other services. They have your cash with a custodian. They cannot invest your capital as they please.
For example, Schwab has $550 billion on their balance sheet but has trillions of capital under management with custodians. The money on their balance sheet is not being lent out, but rather an asset due to earnings from service fees.
SIPC Insurance Defined
The Securities Investor Protection Corporation (SIPC) is a nonprofit membership corporation that was created by federal statute in 1970. SIPC protects customers of SIPC-member broker-dealers if the firm goes bankrupt. Coverage is up to $500,000 per customer for all accounts and covers investments up to $250,000 in cash. SIPC insurance is per account holder, i.e., per person. Separate accounts of the same type for the same individual are not covered, i.e., two taxable brokerage accounts. Separate types of accounts are covered, i.e., 401k vs taxable.
FDIC vs. SIPC Insurance
FDIC insurance covers $250,000 per account, while SIPC insurance covers $500,000 per account type. FDIC insurance is blanket coverage, while SIPC insurance is not. FDIC Blanket coverage covers fraud, forgery, counterfeit etc.
SIPC insurance only covers the firm’s business failure. Both insurances cover cash, but only SIPC covers investments. SIPC insurance covers equities, treasury securities, money market mutual funds, and certificates of deposit (CDs), while FDIC insurance covers checking, savings accounts, joint account, money market accounts, certificates of deposit (CDs). Finally, neither FDIC nor SIPC covers investment fraud.
FDIC vs SIPC insurance
|Insurance coverage amount||$250,000 per account-holder (e.g. 2 person on a joint account get 500k coverage)||$500,000 per account type|
|Covers cash||Yes||Yes (up to $250k)|
|What is covered||Checking, savings accounts, joint account, money market accounts, certificates of deposit (CDs)||
|Covers investment fraud||No||No|
What is a money market fund at brokerages?
A money market fund is a type of mutual fund that invests in low-risk, short-term securities such as certificates of deposit, Treasury bills, and commercial paper. Money market funds are designed to provide investors with a low-risk, low-return investment option that offers liquidity and stability.
Money market funds typically seek to maintain a stable net asset value (NAV) of $1 per share. This means that the fund’s investment manager at a brokerage tries to keep the value of the fund’s assets and liabilities equal to $1 per share. The idea is this will track a dollar and provide interest/yield. As a result, money market funds are often considered a safe place to park cash, as they are relatively stable and easy to access.
Money market funds are often used by investors as a place to hold cash while they are waiting to invest in other securities or to meet short-term financial obligations. They are also commonly used by corporations and institutions as a way to manage their cash holdings.
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How do money market funds get higher interest rates?
Money market funds may seek to achieve higher interest rates by investing in short-term securities with higher yields. This means that the fund manager may invest in securities with longer maturities or lower credit ratings, which carry higher risks but also offer higher returns.
For example, a money market fund may invest in commercial paper issued by a company with a slightly lower credit rating, which carries a higher yield than commercial paper issued by a company with a higher credit rating. Alternatively, the fund may invest in longer-term securities, such as Treasury notes or bonds, which also offer higher yields than shorter-term securities.
It is important to note that higher returns generally come with higher risks. Money market funds that invest in higher-risk securities may be more volatile and have a greater potential for loss. Therefore, investors should carefully evaluate the risks and rewards of investing in a particular money market fund before making a decision.
What are top money market funds to consider?
Here are some of the top money market funds in the United States based on their assets under management and reputation in the industry:
- Vanguard Prime Money Market Fund (VMMXX)
- Fidelity Government Money Market Fund (SPAXX)
- Schwab Value Advantage Money Fund (SWVXX)
- BlackRock Liquid Assets Fund (BRCXX)
- JPMorgan Prime Money Market Fund (JPMXX)
It is important to conduct thorough research and compare the expenses, minimum investment requirements, and investment strategies of each fund before making a decision. Additionally, investors should consult with a financial advisor to determine which investment option aligns with their investment goals and risk tolerance.
So Is Your Money Safe in a Money Market at a Brokerage like Vanguard, Schwab, Fidelity, etc?
Brokerage failures are very rare. You should ask your fiduciary investment advisor if all the funds at your brokerage are with a custodian. Ask if there is excess SIPC insurance.
Ultimately, investing is not risk-free, of course. Even though we have historically thought that the dollar is low risk, the cost to insure treasuries in credit swaps has increased dramatically due to increasing risks we discussed last week.
Stay diversified, keep working on your journey towards financial independence. Personally, we keep our investments across a variety of institutions whether it’s banks, brokerage firms, or other financial institutions.